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Collaboration and Reputation

Just One Goat

‘Just One Goat’ – J. Davies (2020)

 

Collaboration and Reputation

“Regard your good name as the richest jewel you can possibly be possessed of, for credit is like fire; when once you have kindled it you may easily preserve it, but if you once extinguish it, you will find it an arduous task to rekindle it again.”  – Socrates (470 – 399 BC)

 Why Is Reputation Important?

Effective collaborative relationships are underpinned by trust, and by extension reputation. The reputation of an organisation is a strategic asset and a significant source of corporate value as observed by Eccles et al:

“…in an economy where 70% to 80% of market value comes from hard-to-assess intangible assets such as brand equity, intellectual capital, and goodwill, organizations are especially vulnerable to anything that damages their reputations.[1]

There are significant examples of organisations who have destroyed corporate value because they did not adequately protect their reputation. These examples include poor risk management practices such as BP with the Deepwater Horizon Disaster,  fraudulent conduct such as Volkswagen’s emissions cheating practices,  and highly imprudent statements about product quality such as the Chairman of a large jewellery retail chain publicly stating that the company’s products are “complete crap”.[2]

Failure to operate your company is a ‘sound and business-like manner’ and with ‘reasonable skill and care’ is not only unlawful in most jurisdictions[3] but also a sure-fire way to erode value and destroy trust.  Doing what you say you are going to do, behaving ethically, and treating your customers with respect are all simple strategies to build up and maintain positive relationships. We also need to consider reputation more broadly between buyers and suppliers, especially with strategic suppliers and customers. 

The current global pandemic is generating extreme volatility and uncertainty in business relationships.  The temptation to retreat into silos with a ‘dog eat dog’ approach may yield very short-term benefits; however, smart companies will play the long game and focus on how the business will operate after the crisis is ended. In other words, these companies will look to preserve or even enhance their reputations

Strategies for Preserving Your Reputation in a Crisis

In a crisis, an organisation may be legally frustrated from delivering what they promised. This can apply to organisations involved from both the buy side and sell side. A black letter law approach would push businesses towards efficient breach of the contract or litigation to resolve the issue (often through legal technicalities) but as we know, such approaches destroy trust and annihilate opportunities for parties to work effectively with each other in the future. Organisations therefore need to explore options for win-win outcomes through the following:

Transparency. Be honest and do not surprise your suppliers or customers.  Early and frank disclosure will more likely preserve trust and allow for joint, mutually agreed solutions.

Demonstrate Leadership. Be a role-model to your teams, customers, and suppliers. Be proactive, be courageous, and do not let issues fester. Problems rarely go away by themselves.

Maintain Flexibility. Two millennia ago, the Roman statesman, Publilius Syrus stated that, ‘it is a poor plan that admits to no modification’. This tenet is especially relevant now. Organisations need to accept that existing Business Cases, Corporate Plans, Profit Forecasts, and Programme Charters are likely to be superseded by events. Stubborn organisations that do not adapt their strategies and plans will likely fail. Successful organisations, that work collaboratively with buyers and suppliers to promote flexibility and agility,  will more likely succeed.

Negotiate to Create Value. Negotiation does not have to be a zero sum game. Adopt a positive approach to negotiation that explores opportunities for both parties and the creation of value.

Fix the Problem and not the Blame. When the proverbial hits the fan, there is an overwhelming temptation to start pointing fingers. We need to resist this temptation and focus our energy on fixing the problem.

Adopting the above strategies will not guarantee preservation of goodwill but will be far more likely to avoid losing a cherished reputation. Organisations may also seek a crisis to enhance their reputation and prove that they can work collaboratively in both good and bad times.

Summary

When a crisis strikes, we naturally focus on short term survival. This is absolutely necessary where cash flow and solvency is at risk and other extreme risks or issues place business viability in jeopardy. Like Maslow’s hierarchy of needs,[4] we should not ignore these critical factors but at the same time we also need to be future focused and explore how the organisation will look and work at the end of the crisis.  Short-term survival does not have to be at the expense of long-term relationship building. Organisations now have a unique opportunity to demonstrate their affinity to collaboration in good times and bad.  Playing the long-game, from a collaboration perspective, should be a strategic priority.

[1] Robert G. Eccles , Scott C. Newquist and Roland Schatz “Reputation and Its Risks” Harvard Business Review February 2007.

[2] Gerald Ratner, After Dinner Speech to UK Institute of Directors (Apr 1991).

[3] Companies Act 2006 (UK) s174; Delaware General Corporation Law Delaware s145; Canada Business Corporations Act (1975) s122; Corporations Act 2001 (Cth) s180.

[4] Maslow, A. H. (1943). A theory of human motivation. Psychological review,50(4), 370.

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Disputes and Issues Resolution – Best Practice for Collaboration (Part 2)

“One is not exposed to danger who, even when in safety is always on their guard.” – Publilius Syrus (circa 60 BC)

ludit lexus

Ludit Lexus  – J.Davies (2020)

Introduction

In part one of our discussion on disputes and issues resolution, we explored strategies for effectively dealing with disputes internally. The key theme here was to resolve issues quickly, fairly and at the lowest possible level.  In some circumstances though internal mechanisms may be insufficient to resolve critical disputes.  In our current volatile and uncertain environment, some aspects of the commercial relationship may not be possible to perform and the contract could be frustrated.[1] Even force majeure can introduce substantial uncertainty to the performance of the contract.  We therefore need to anticipate mechanisms to deal with serious issues that cannot be effectively resolved through internal measures.  We should not rely on litigation or arbitration to seek resolution.  Litigation and arbitration are very time consuming, expensive and uncertain processes that are very unlikely to support future positive relationships. Consequently, we must explore other, less destructive, external resolution mechanisms.

External Disputes Resolution Options

In our first blog we recognised that disputes and issues resolution processes and largely unfettered so long as they do not ‘oust the jurisdiction of the courts’.  This means that we are free to select any form of disputes and issues resolution process so long as the commercial agreement does not fetter any party in pursuing litigation until after the dispute resolution process has run its course. For effective collaborative outcomes we need to adopt the same mantra of disputes and issues resolution principles we explored earlier; that is resolve quickly, fairly and at the lowest level practical.  Once we move to external disputes resolution, solving problems at the lowest level means anything other than arbitration or litigation. Best practice resolution here includes mediation and expert determination

Mediation

The Resolution Institute offers a succinct definition of mediation as follows;

Mediation is a confidential process where an independent and neutral third party assists the disputants to negotiate and reach a decision about their dispute.[2]

The role of the mediator is not to impose a solution or binding outcome, rather the mediator facilities a joint, win-win outcome by exploring issues and positions of the parties collaboratively.

A mediator will only participate in the process if all parties are committed to resolution of issues in good faith.  Mediation is usually the quickest and cheapest of all the external dispute resolution processes and is also more likely to preserve positive business relationships.

Expert determination

For technical disputes, an expert can be employed in a resolution role. Quite often the expert’s ruling is considered binding.  The Australian Institute of Arbitrators and Mediators recommend the following rules apply to expert determination:

  1. The Expert shall determine the Dispute as an expert in accordance with these Rules and according to law.
  2. The parties agree that:
    1. the Expert is not an arbitrator of the matters in dispute and is deemed not to be acting in an arbitral capacity;
    2. the Process is not an arbitration within the meaning of any statute.
  3. The Expert shall adopt procedures suitable to the circumstances of the particular case, avoiding unnecessary delay and expense, so as to provide an expeditious cost-effective and fair means of determining the Dispute.
  4. The Expert shall be independent of, and act fairly and impartially as between the parties, giving each party a reasonable opportunity of putting its case and dealing with that of any opposing party, and a reasonable opportunity to make submissions on the conduct of the Process. [3]

For more complex and long-term commercial arrangements, parties may pre-select the expert for each discipline area. For example, the parties could pre-select an expert for pricing issues, technical solutions, or for contract interpretation.

There are several permutations in how the expert can decide on an issue. In most cases, the expert is free to come to their own conclusions as to how the dispute should be settled. In other cases, the expert may be bound to select a course of action between the ambit of the parties’ positions.

A variation of the expert determination decision making process is final offer arbitration or baseball arbitration.[4] In this situation, an expert is only permitted to select one course of action provided by one of the parties. There is no scope to select within the middle ground. Consider the following example:

A supplier is seeking additional sums related to a substantial contract change proposal initiated by the customer.  The customer is expecting a $100,000 increase in costs associated with the change, whereas the supplier expects the change to incur an additional $500,000 in costs. If the parties wish to resolve this issue via baseball arbitration, then they will need to submit a best and final offer to the arbitrator. Each party does not get to see the final offer from their counterparts.  The arbitrator will estimate the cost of the contract change proposal and will select the best and final offer that is closest to their expert estimate.  In this example, the expert may decide that the additional costs are $250,000. If the customer digs in their heels and sticks to the $100,000 additional sum, but the supplier is more reasonable and adjusts their escalation fee to $300,000 then the arbitrator will select the $300,000 escalation fee since this figure is closest to the arbitrator’s estimate.

Baseball arbitration prevents any one party making outrageous or unfair claims for fear that their claim will be considered less equitable or fair when compared to the other party’s claim. This can be implemented relatively quickly and cheaply provided there is an arbitrator with the necessary skills available.  By design, this approach nudges parties to provide reasonable offers and will likely preserve business relationships.

Conclusions

For resolving disputes and issues, we must first craft a commercial strategy that minimises the likelihood of disputes and issues arising in the first place. Fair and equitable risk allocation, early engagement, and transparency are all tools we can adopt to achieve this. Nonetheless, we need to anticipate disputes arising and ensure our contract has effective internal disputes and issues resolution processes.  With an effective collaborative culture, we should not expert disputes and issues to require external resolution processes, but we should not create a situation where arbitration and litigation is the only step available to us.  Mediation and expert determination should be considered, especially for longer term, strategic relationships.

[1] J. Curle & C. Allin ‘Coronavirus COVID-19 and frustration: Is your contract at risk? (United Kingdom)’ (Mar 2020)  https://www.dlapiper.com/en/chile/insights/publications/2020/03/coronavirus-covid-19-and-frustration-is-your-contract-at-risk/

[2] Resolution Institute (2017)  https://www.resolution.institute/dispute-resolution/mediation

[3] Resolution Institute (2017) https://www.resolution.institute/dispute-resolution/expert-determination

[4] L. Samples ‘Resolving Construction Disputes through Baseball Arbitration’ American Bar Association (2019)

Managing Uncertainty through Collaboration

           “We demand rigidly defined areas of doubt and uncertainty!”    – Vroomfondle the Philosopher, in Douglas Adams The Hitchhiker’s Guide to The Galaxy (1979).

Introduction

In our previous blog, we explored how collaborative management of risks and opportunities can lead to superior outcomes. Whilst issues (known knowns) and risks (known unknowns) can be relatively easy to manage, a more critical challenge arises with uncertainty. Uncertainty can manifest itself as either:

  1. Unknown knowns. Things we know about, but we may have incomplete information about their likelihood or consequence.
  2. Unknown unknowns. These are simply things that are not contemplated (sometimes referred to as unfathomable uncertainty).[1]

We previously mentioned that a contract is a tool that is used to allocate risk but how can we manage uncertainty where the risk is simply not contemplated, or risk likelihood or consequence cannot be reliably quantified?  This blog explores strategies on how we can effectively craft a commercial model that better deals with uncertainty. 

When to Focus on Uncertainty?

Whilst uncertainty is relevant to all commercial dealings, the impact of uncertainty is more likely to arise within certain environments. Remington and Pollack offer a useful framework to help us gauge the level of complexity in a project, and hence where we need to focus our efforts in dealing with uncertainty.

  1. Structural Complexity. Many interdependent systems or components
  2. Technical Complexity. New technologies or new ways of business
  3. Directional Complexity. Many diverse and influential stakeholders with competing needs.
  4. Temporal Complexity. Unanticipated changes in regulations, law, and environment.[2]

In summary, high complexity often creates an environment where uncertainty is more likely to have an impact of the delivery of outcomes. How then do we create a commercial model to effectively deal with uncertainty?

Crafting a Commercial Model to Deal with Uncertainty.

Traditional arms-length contracts are often underpinned by waterfall development life cycles whereby the principal provides the contractor with a specification, statement of work, and conditions of contract to deliver the contract works.  In complex environments, such approaches are often unsuitable as uncertainty introduces change and emergence that is often not contemplated in the contractual risk allocation framework and procurement documentation.  We may therefore need to adopt a more exploratory procurement model where we ‘probe, sense, respond’ rather than the traditional ‘sense, categorise, respond’ approach we see in simple procurement activities.[3] There are several ways to achieve this including:

  1. Contracting for incremental outcomes and exploiting prototypes. An evolutionary approach mitigates many of the challenges associated with uncertainty by allowing us to ‘probe’ the environment, explore the art of the possible, and create ‘early wins’. Incremental approaches also provide natural ‘off-ramps’;
  2. Maximise tradespace.  Providing maximum flexibility and agility to trade off cost, schedule, and performance parameters. This approach allows a collaborative means to realise benefits even when new, significant risks and issues emerge; and
  3. Create an adaptable organisation and culture that can cope with change. Traditional approaches rely on stable requirements, certainty, and linearity. To effectively deal with uncertainty we need to create an environment where all key stakeholders understand that change is a natural part of the process and we have the right leaders to communicate how change can be an effective tool to achieve the project ‘vision’.

Recognising that there is no pre-ordained path to delivering outcomes will go a long way to helping us deal with uncertainty, but we still need to get into the contractual ‘nitty gritty’ of managing change, implementing suitable risk and reward mechanisms, and dealing with the prospect of cancelling the contract if uncertainty jeopardises the business case. 

Change Management Processes 

Uncertainty can create significant challenges including increased costs, delays, and force change in delivery methods.  Anticipating all possible permutations that may occur throughout the contract lifecycle is a fool’s errand so we must implement robust and fair change management processes.  We need to remind ourselves that there is no price competition associated with variations in a contract so we must ensure any change management process balances fairness, timeliness, and value. This is where a culture of collaboration will reap dividends. Where parties work on a best for project basis with shared goals, and shared information; change management will be far more effective.   Collaboration also allows opportunities to be recognised and exploited when circumstances change.

Risk and Reward

Traditional fixed price, arms-length contracts are unsuitable for contracts involving high uncertainty. A commercial model is therefore required to encourage parties to fix the problem and not the blame when new risks emerge.  A firm fixed price contract where suppliers face unlimited liability for all risks and with no recourse to force majeure will drive the wrong commercial behaviours. Similarly, a cost reimbursement contract where the buyer assumes all risks will unlikely deliver value for money. As we have stated in many previous blogs, a commercial model is needed where buyers and suppliers both have ‘skin in the game’ and are incentivised to work collaboratively to proactively manage new risks and exploit new opportunities. 

Termination

Where a magnitude of change arising from uncertainty is significant, then this could jeopardise the procurement business case or value proposition. In such circumstances, termination or significant rescope of the project must be considered.  Collaboration is necessary to ensure a seamless closure of the project, reduce disputes, and capture lessons learned.  Preservation of business relationship is also of critical importance. By adopting collaborative contract principles, we are more likely to effectively manage radical changes in scope.  We need to make sure that the commercial framework supports timely exchange of information so that there are ‘no surprises’ for either buyers or suppliers.  Termination clauses must also be reasonable, fair and therefore contemplate ‘reasonable de-mobilisation costs[4]

Conclusions

Dealing with uncertainty is something that is often overlooked in contract management as this is a very hard topic to deal with.  Collaboration is a key tool when dealing with complex projects where we anticipate uncertainty. We need to make sure we manage stakeholders effectively, implement robust and fair change management processes and establish a commercial framework where all parties share in risks and rewards.


[1] Kim, S. D. ‘Characterizing unknown unknowns’ (2012) PMI Global Congress 2012—North America.

[2] Remington, K., & Pollack, J. Tools for Complex Projects (2007)

[3] David J. Snowden and Mary E. Boone ‘A Leader’s Framework for Decision Making’ Harvard Business Review (November 2007).

[4] Gray A. ‘Unfair Contract Terms: Termination for Convenience’ [2013] University of Western Australia Law Review 12 (2013) 37(1) 229 at 250.

Benefits Realisation Through Joint Management of Risk and Opportunity

Small opportunities are often the beginning of great enterprises.” – Demosthenes (384 – 322 BC).

Introduction

The overwhelming majority of commercial arrangements are underpinned by contracts.  The contract is largely used as a tool to allocate risk but the way we often use contracts to manage risk is ineffective for many reasons.  First, there is asymmetry of information where parties are unaware of what risks actually exist, what the likelihood of risks are, and their consequences. Secondly, the risk allocation process is often controlled by the buyer and this often results in unfair risk allocation. Thirdly, we become so obsessed by managing risks that we fail to explore opportunities and value creation.   In other words, we end up leaving substantial value on the table during negotiations and beyond.  This blog explores strategies to improve the way we manage risk and opportunities through collaboration.

Risk and Opportunities Identification

It would be remarkable if a buyer fully comprehends all relevant risks associated with the goods and services they are procuring.  It is highly likely an asymmetry of information[1] exists whereby the supplier has a more comprehensive and accurate understanding of the risks associated with their deliverables.  Similarly, suppliers may not have a full appreciation of the customer’s environment, constraints, and motivations.  Typical commercial negotiations are underpinned by this bilateral asymmetry of information and this results in suboptimal outcomes.  There are some strategies that are often used to counteract an imbalance of information such as:

  1. Contracting for an ‘outcome’ rather than a ‘thing’,
  2. Relying on price competition to ensure price (not necessarily value) is fair,
  3. Performing due diligence such as referee checks, customer testimonials, exploring defect rates etc.

Whilst the above strategies may provide some confidence that the goods and services provided are fit for purpose, there are significant limitations where competition is constrained, there is a selection bias in referees/testimonials, and with the failure explore value creation. 

Rather than adopt an arms-length commercial approach, a collaborative approach with early engagement is far more likely to capture all relevant risks associated with the contracting function but more importantly, identify opportunities to create value. This can be achieved with buyers and suppliers working together in a joint risk and opportunities workshop to gain a better understanding of the risks and opportunities upfront. 

The two stage Early Contractor Involvement (ECI) contract is a very good example of collaborative risk and opportunities management. Under the ECI process, the buyer and suppliers work together early in a preliminary stage to jointly identify risks and opportunities in a collaborative fashion.[2]  All options can be explored in this stage, there should be no unnecessary constraints.  Once complete, the parties further work together to explore who is best placed to manage the identified risks. This may involve risk transfer or even risk sharing. Insurance brokers may also be invited to participate in these workshops where risks can be allocated to third parties.  We need to recognise that this preliminary stage does not have a default risk allocation strategy, a default contract template, or pre-defined remuneration strategy. It is up to buyers and suppliers to jointly work together to determine the most suitable commercial framework well before the head contract is signed.  Working together collaboratively eliminates most of the challenges associated with asymmetry of information and ensures the final cost estimates and schedules are realistic.[3] 

Fairness in Risk Allocation

Joint management of risk and opportunities will inherently support fairness in the commercial relationship. We mention previously in collaborative contracting blogs that unfair risk allocation can severely erode value:

Inappropriate allocation of risk resulted in a 14 percent increase in costs to projects. Of this amount, the customer was liable for 78 percent of the cost increase.[4]

We discussed the downsides of unfair risk allocation in our blog on commercial models  but what are the benefits of fair risk allocation?  Fair risk allocation eliminates many unwarranted contingency fees or management reserve being added to the supplier’s contract prices.  More importantly though, a fair and equitable commercial framework encourages parties to share information, explore continuous improvement and innovation, and focus efforts on pursuing opportunities.    A focus on risk transfer does the exact opposite.

Consider a firm fixed-price arms-length contract where the customer allocates as much risk as possible to the supplier.  In this situation, the key motivation of the supplier is to spend all their efforts on risk abatement, deliver outcomes only within the strict boundary of the contract, and ignore any deviations from the contractually delivered ‘plan’.  If we are serious about benefits realisation, a more considered approach is needed that;

  1. Encourages joint risk and opportunities management;
  2. Ensures a risk and reward structure is implemented that is fair and reasonable;
  3. Encourages parties to work towards delivering enterprise goals (which also includes a vibrant, sustainable, and profitable supply base);
  4. Focusses efforts on fixing the problem and not the blame; and
  5. Tolerating prudent risk taking, consistent with the approach of fail fast, fail cheap, fail often, fail safe, and fail smart.[5]

A joint approach to managing risk and opportunity registers with a single of truth is far more likely to foster innovation and value creation. A single source of truth that represents a holistic picture of project risk is also far more valuable to all stakeholders.  This can be achieved via a joint liability risk assessment or risk log that explore risk as a probability distribution.  The quality of this risk assessment will also be far superior as both buyers and suppliers are involved.  A probabilistic analysis can be undertaken to explore most likely, worst case, and best-case scenarios for delivering outcomes. Buyers and suppliers can then adopt a mutually informed negotiation process to reach a commercial agreement but more importantly, all parties can work collaboratively to mitigate risks. 

For those that want to explore probabilistic risk assessments further, I have developed a creative commons (free for commercial use) liability risk assessment template which converts three-point estimates for any number of risks into a probability curve and cumulative probability distribution. This tool is based on a PERT Beta distribution[6] using a 10,000 point Monte-Carlo simulation.  The tool allows users to derive expected value (p50) and best case/worst case estimates for known risks. This tool provides an understanding of the spread of risks on a project and informs the best commercial model for both buyers and suppliers and can be downloaded from the below link.

Monte Carlo Risk Analysis Tool

Dealing with Uncertainty and Estimation

Managing the known risks is arguably the easy part. Crafting a commercial framework that effectively deals with uncertainty (the unknown unknowns and known unknowns)[7] is far more challenging. The traditional approach of dealing with uncertainty with indemnities and managing change through variations rarely delivers value. The topic of our next blog will explore strategies to craft a commercial relationship that does effectively deal with uncertainty. 

Conclusions

Managing risks and opportunities jointly through early industry engagement is far more likely to create value. A shift to collaborative risk and opportunities management though does require a move away from traditional boilerplate contracts and tender evaluation processes. What is needed is a commercial model that explores risks and opportunities at the enterprise level and drive parties to proactively explore these opportunities to realise joint benefits.


[1] George A. Akerlof ‘The Market for “Lemons”: Quality Uncertainty and the Market Mechanism’ The Quarterly Journal of Economics Vol. 84, No. 3 (1970).

[2] Roger Quick, ‘Queensland ECI Contract’ ICLR [2007].

[3] Queensland Government Chief Procurement Office Procurement Guidance Series “Relational Procurement Options – Alliance and Early Contractor Involvement Contracts” (2007) at http://alliancecontractingelectroniclawjournal.com/wp-content/uploads/2017/06/Queensland-Government-Chief-Procurement-Officer-ND-Relational-Procurement-Options-Alliance-and-Early-Conractor-Involvement-Contracts.pdf

[4] CII Research Report RR210-11 “Contracting to Appropriately Allocate Risk” (2007) summarised in Altman R., Cruz J., Halls, P “One-sided Contracts: Do They Pay Off?” ACCL Vol 11 1 (2017) p 169.

[5] US Government “Innovative Contract case Studies” (2014), p20.

[6] Vose D., Risk Analysis: A Quantitative Guide 3rd ed (2008) pp 672-4.

[7] Respectively referred to as ontological and epistemic uncertainty.

Agile and Collaboration (Part 2)

In the volatile modern world, flexibility is essential to the survival and success of an organisation” – G. Stracusser[1]

Evaluation and Planning. L.Ruigrok (2020)

Introduction

In our previous blog we explored the features and problems associated with agile procurement approaches. The key challenges with agile procurement stem from the fact that flexibility and responsiveness are not compatible with traditional procurement approaches and associated contracts that attempt to clinically allocate risks between the parties. Similarly, agile approaches require a substantial shift away from business as usual approaches and this demands an organisational cultural shift as well as effective leadership to drive the right outcomes.

Suppliers as Custodians

Traditional, arms-length procurement approaches are suitable for low risk, non-critical procurement but where we wish to successfully implement agile procurement then we need to fundamentally reassess out business relationships. Agile demands flexibility to achieve faster time to market, better meet customer requirements, better deal with emergence, and reduce disputes. This cannot be achieved with a traditional vendor relationship. Rather, we need to change the way we look at suppliers and consider them as trusted partners or custodians of our business. No doubt this makes traditional contract managers exceptionally nervous (from both the buy and sell side) but this change in thinking is necessary for the following reasons:

  1. Bringing suppliers ‘inside the tent’ provides them with greater access to customers, rather than dealing with the contract management team as the gatekeepers. This subsequently allows for timely and more effective decisions, and ensures goods and services are fit for purpose;
  2. Integration of suppliers with common information systems, inventory management systems, risk management systems, and decision support systems provides a timely, single source of truth. As a result, decisions can be made faster and more accurately;
  3. Fixed price arrangements are very difficult to implement in agile environments. As a custodian working closely with the buyer, almost real time evaluation of supplier performance and value can be assessed. This provides a more robust remuneration governance framework than a simple cost reimbursement approach where there is no incentive to minimise costs; and
  4. When things inevitably go wrong, parties should be incentivised to ‘fix the problem and not the blame’.  As a custodian or partner, suppliers are more likely to work towards the customer’s enterprise outcomes rather than their own short-term commercial interests.

Though the above benefits are enticing, we need to be alert to the challenges associated with suppliers as custodians with; potential dilution of accountability, the risk of fiduciary duties arising, and the risks of ‘vendor lock in’.  Appropriate governance and performance management frameworks must be in place to deal with these issues.

Organisational Design

Every company that has tried to manage mainstream and disruptive businesses within a single organisation failed.’ – J. Bower and C Layton[2]

Traditional procurement is often underpinned by stovepipe organisations. This is especially so in large organisations where separate departments and business units work separately in the procurement lifecycle with; the marketing department exploring ‘features and benefits’, engineering departments developing and implementing specifications, commercial departments drafting the contracts, and finance teams crunching the numbers. These activities are typically sequential and often lead to delays, confusion, and a general lack of accountability.  For agile procurement, these stove pipe approaches are unsuitable.  As observed by Nicoletti, an ‘agile business model’ is required with agile processes that maximise the opportunities for automation.[3] In practice, this means:

  1. a single, accountable authority who is delegated decision-making for the agile procurement activity;
  2. an integrated team comprising all the necessary skills and disciplines needed for the procurement activity, including the customer;
  3. streamlined processes that are focussed on delivering an outcome rather than delivering a ‘thing’;[4] and
  4. maximising the opportunities for automation (efficiency, economy, and effectiveness).[5]

Implementing a complete agile procurement suite across the whole business would be a herculean task but there is no binary choice here.  Organisations can adopt the full raft of agile procurement approaches for those activities where it is required and roll out partially agile approaches for the remainder of the business.  For example, automation and streamlined processes could successfully be implemented across the whole enterprise but highly skilled, multidisciplinary teams may be reserved for those activities where the greatest need for flexibility is required.  Organisations facing a transition to agile procurement approaches would likely face significant challenges if they adopted a big bang approach to implementation.  The mix and skills of personnel required in a completely agile procurement environment would also introduce challenges.

Cultural Alignment

Moving to an agile procurement environment will undoubtedly require a cultural shift in many parts of the organisation.  It is rare for large organisations to have a single, homogenous culture, rather there are likely to be cultural islands.[6]  A new cultural island may be required for those business units that are required to operate in an agile fashion. Alternately, a more ambitious approach is to shift the whole organisation to an agile culture.  The latter approach is exceptionally risky even though the rewards are likely to be much higher.  What is important when adjusting culture is that expectations are managed, and change is implemented to achieve enterprise outcomes.  Expectation management requires us to recognise that:

  1. Flexibility and agility come at a price. Long term pricing arrangements, bulk purchasing rebates, and efficiencies with boilerplate processes will be eroded. Nonetheless, the loss of these benefits should be eclipsed by the value offered by an agile, customer focussed, responsive organisation;
  2. The organisation must have a greater appetite for sunk costs and rework.  Consistent with the Fast, Inexpensive, Restrained and Elegant, and other innovative procurement methodologies; we should accept failures so long as failures are ‘fast, cheap, often, and smart’;[7]
  3. The full range of benefits will only be realised when buyers and suppliers work together collaboratively
  4. We must accept shorter planning cycles. Strategies are enduring but planning cycles must be shorter to deal with emergence and support agility.  Five-year plans are anathemic to agile procurement approaches. Our business cases must be regularly updated, revised, and even rejected as new information becomes available.  Continuing viability of plans must be undertaken;[8] and
  5. The organisation as a whole must be resilient and adaptable. Emergence means that people and processes must be aligned to allow the organisation to pivot as required. This can introduce challenges with change fatigue.

Conclusions

An agile organisation offers substantial benefits so long as the organisation is effectively designed with the right culture and with expectations managed accordingly.  Agile approaches will be successful if they are underpinned by small, self organising, multi-disciplinary, collaborative, high performing teams.[9] Assigning grandiose titles to these teams such as ‘tiger teams’, ‘black belts’ or ‘scrum masters’ is not important. What is important is to ensure these teams have the right people, with the right skills, and the right delegations to achieve enterprise goals. 


[1] Straçusser, Glenn Agile project management concepts applied to construction and other non-IT fields (2015) https://www.pmi.org/learning/library/agile-software-applied-to-construction-9931

[2] J. Bower and C Layton ‘Disruptive technologies – Catching the Wave’ Harvard Business Review Jan/Feb 1995 Vol 73 Iss 1.

[3] Bernardo Nicoletti  Agile Procurement: Volume I: Adding Value with Lean Processes (2018) p4.

[4] J. Millis & A. Freeman ‘Agile contracting for Australian Government agencies (2018).

[5] Bernardo Nicoletti  Agile Procurement: Volume I: Adding Value with Lean Processes (2018) p4.

[6] E. Schein, Organizational Culture and Leadership 4th Ed (2010), p 271.

[7] US Government ‘Innovative Contract Case Studies’ (2014) pp24-25.

[8] Managing Successful Projects with Prince2 (2017) [6.2].

[9] F. Brooks “Mythical Man Month” (1975)

Agile Procurement and Collaboration (Part 1)

“It is a bad plan that admits to no modification” – Publilius Syrus (fl. 85–43 BC)

“Becoming agile in procurement allows you to create an adaptive partner ecosystem where you adapt to needs and circumstances in a relationship rather than having contractual handcuffs on.”[1]

Introduction

Agile procurement is a hot topic as organisation’s are seeking agility and responsiveness in an exceptionally volatile environment.  Pinning down a definition of ‘agile’ in the procurement space though is illusive.  Whilst the term has its origins in the software development arena with the agile manifesto , agile procurement means many different things to many different stakeholders. This blog explores some of the definitions of agile procurement and the common themes or principles that emerge out of the literature.  One of these key recurring themes is the need for collaboration at all levels to realise the benefits of agile approaches. Successfully implementing agile approaches through collaboration is the theme of part two of this blog.

Agile in the Software Development Domain

Almost two decades ago the agile manifesto was born with the following values:

  1. Individuals and interactions over processes and tools
  2. Working software over comprehensive documentation
  3. Customer collaboration over contract negotiation
  4. Responding to change over following a plan[2]

Along with the 12 principles of agile, the aim was to avoid lengthy waterfall development approaches by adopting short development cycles, meeting customer needs, and embracing change. Whilst the agile manifesto offers a neat summary of what is arguably best practice, there is a lot of prior art that captured many of these agile principles many decades earlier.  Kelly Johnson (of Lockheed Martin Skunkworks fame) embraced the principle of ‘keep it simple’ and his 14 rules identified the need for buyer and supplier collaboration with ‘very close cooperation and liaison on a day-to-day basis’, and the use of small and skilled teams. Likewise, in Brooks’ Mythical Man Month he emphasised the need for small, agile, high-performing teams developing minimal viable products.  Like many initiatives, the agile manifesto captures best practice and builds upon it.  In all things, we should treat agile principles as exactly that; principles not rules.

Agile Procurement

The success of agile in the software domain raised questions about whether such approaches could be effectively applied in the procurement space.  No doubt, procurement practitioners wanted to reap the claimed benefits of agile approaches including:

  • Faster time to market (noting that speed and value are interlinked),
  • Enhanced customer satisfaction,
  • Dealing with change effectively, and
  • Reduced conflict and enhanced collaboration.

Can these benefits be achieved in the procurement function? The answer is ‘of course’ and agile procurement approaches have been implemented in various guises for many years.  A cost reimbursement contract with supplier and customer integrated product teams is a clear example of how procurement can be agile. Similarly Cost As an Independent Variable (CAIV) approaches support many agile features such as; a focus on collaboration with early and continuous end user participation, a focus on minimum viable products, ability to trade high level requirements, and the promotion of flexibility. Whilst these approaches have been used effectively at the project and program level, the shift to agile approaches at the enterprise level is a more recent initiative. 

When we move to the enterprise level, we need to ensure the whole organisation is aligned to agile principles and not just the procurement function.  This means focusing on strategic objectives and adopting a top down approach as observed by NaDaud:

Agile procurement addresses big picture business needs rather than automatically finding solutions comparable to what is in place and re-bidding the demand. This might result in the selection and implementation of a solution that looks completely differently than what has been done in the past but satisfies the same objective.[3]

In essence, agile procurement is nothing remarkable. Agile requires us to focus on enterprise objectives (with a strong customer emphasis), ensure our process do not slow us down, achieve outcomes rather than specify how to do things, and effectively collaborate with all stakeholders. This does not mean we have to abandon traditional sourcing strategies, rather we must be able to select agile methods when they are required.  Mitchell makes this clear in the following observation (emphasis added)

Agile procurement is the ability to satisfy all of the objectives of strategic spend management (savings, resource efficiency, risk management, supplier performance/relationship management) without the rigidity of being tied to any of the typical ways we achieve those things. [4]

Agile is not the death knell of the Kraljic Matrix or Category Management approaches. Many organisations will still maintain a section of their portfolios that will require more traditional approaches, but agile demands that deviation from boilerplate templates and traditional processes is permitted. Where we have complex emergent environments, unknown solutions, a demand for innovation, and a need for end-user participation, then the business case for pursuing agile is compelling.[5]

The Problems with Agile

A procurement delivery system that offers all the benefits of agile is enticing but we must be alert to the challenges or risks of going agile. First, we need to recognise that agile is not a free for all with an unstructured, no-liability, cost reimbursement contract where contract managers simply ‘tick and flick’ progress reports independent of any value being delivered. As Rigby, Sutherland and Takehuchi state, ‘agile is not anarchy’.[6]  With agile, there must be appropriate governance arrangements in place and a flexible commercial model that incentivises performance.  This is not just the remuneration model but also other non-price factors such as the amount of workshare and security of supply with possible guarantees for follow on work.  Herein lies a major challenge, how do we legislate for a flexible process with a contract? By design, contracts are tools that allocate risks and liabilities, provide stringent processes for managing change, and clearly articulate the contractual outcomes.  Whilst not insurmountable, we can craft contracts and commercial models to deal with agile environments and this will be explored in out next blog. Suffice to say, adopting a commercial framework that is agile friendly, requires a radical departure from traditional contracting approaches and this brings us to the next problem, culture.

For many organisations, operating in an agile environment will require a substantial shift from business as usual approaches.  Having the right culture with leadership participation is crucial for successfully implementing agile approaches.  The importance of leadership and the right culture is illustrated  in the 14th Annual State of Agile Report  which states that the top barriers to realise agile outcomes are:

  1. general organisation resistance to change,
  2. not enough leadership participation,
  3. inconsistent processes and practices across teams,
  4. organisation culture at odds with agile values, and
  5. inadequate management support and sponsorship.[7]

Rigby et al go further to claim that traditional organisation structures and C- suite activities are unsuited to agile methodologies.[8]  To successfully embark upon agile approaches, a cultural transformation with leadership support is needed.

A further challenge with agile approaches is with the skills and capacity of the team members who must make agile methods work.  One of the key organisational drivers for adopting category management and segmented purchasing (with tools such as the Kraljic matrix) is to enable procurement professionals to only be given the training and skills they need for their job.  For example, the skills needed to manage ‘non-critical items’ are quite modest compared to ‘strategic items’. Where we move to agile procurement, contract managers and procurement professionals require more formidable skills, training, and experience. Even more so, we need people with the ‘mental agility’[9] to drive value.

Conclusions

Agile procurement offers many benefits but there are risks and cost associated with adopting agile in an organisation. None of the challenges with Agile are insurmountable. Our next blog will explore practical aspects of implementing agile approaches through collaboration, cultural alignment, commercial alignment, and effective expectation management. 

For those who are interested, Dr Andrew Jacopino and myself are hosting a network session on Agile Contract Models and Performance Based Contracts as the IACCM Vibe Summit on Tuesday September 22nd, 5:40pm – 6:15pm AEST.


[1] D. Craik ‘How to be an Agile Procurement Team’ (2018)  https://www.cips.org/supply-management/analysis/2018/october/how-to-be-an-agile-team/

[2] https://agilemanifesto.org/

[3] J. Nadaud ‘Agile procurement defines next wave of success – how well do you walk the talk?’ https://journal.iaccm.com/contracting-excellence-journal/agile-procurement-defines-next-wave-of-success

[4] M. Mitchell ‘What does Agile Mean Anyway?’ (2018) https://www.determine.com/blog/what-is-agile

[5] D. Rigby, J. Sutherland and H. Takeuchi’ Embracing Agile’ Harvard Business Review (May 2016) https://hbr.org/2016/05/embracing-agile

[6] Ibid.

[7] Digital AI “14th Annual State of Agile Report” (2020)  https://explore.digital.ai/state-of-agile/14th-annual-state-of-agile-report.

[8] Rigby et al, opcit.

[9] T. Cummins ‘Agility, contracts and value: time for new thinking’ (2019) https://commitmentmatters.com/2019/09/22/agility-contracts-and-value-time-for-new-thinking/

Collaboration and Partnering Principles

Clearly, the best dispute resolution is dispute prevention. Acting to prevent disputes before they occur is key to building new cooperative relationships. ” – Lieutenant General H. Hatch, Commander, U.S. Army Corps of Engineers[2]

What is Partnering?

Partnering approaches have been used for many decades, bringing customers and suppliers together to deliver outcomes and move away from transactional and adversarial relationships. Partnering promotes common goals, timely communication, effective disputes resolution, and a commitment to excellence as illustrated in Figure 1 below:

Figure 1: Partnering Concept[3]

We must recognise that partnering is a process that helps align goals, encourages teamwork, and fosters joint problem solving. Partnering operates outside of the contract but should only be pursued where the commercial arrangements are consistent with partnering principles. To realise partnering outcomes, we typically rely on a non-binding partnering charter. The partnering charter has no legal force. As observed by Briggs, the partnering charter is more of a ‘moral commitment’.[4]

Partnering can be used in conjunction with most forms of contract, though partnering will be more successful where contracts allow parties to work collaboratively. Partnering does not mean that risks must be shared or that fixed price arrangements will not work. Stephenson makes this point clear:

“The basic partnering concept is relatively simple and is not intended to give rise to a change in the legal structures, which regulate the risk of the participants to the project.[5]

The Alberta Infrastructure and Transport Partnering Guidelines also provide valuable insights into what partner is not:

“Partnering is NOT about relaxing the contract terms or circumventing the processes, it is NOT about expecting service providers to do “extra” work for free, it is NOT simply about dispute resolution.”[6]

Is Partnering Successful?

Numerous studies have shown that where partnering principles are applied, superior project outcomes are more likely to emerge.[7]  We should be alert to a correlation fallacy here though in that buyers and suppliers who are committed to reasonableness, cooperation, and reject adversarial behaviours are more likely to select partnering approaches. Consequently, it is more likely that a collaborative culture and mindset will drive superior outcomes and selection of the partnering process is a natural symptom of these positive behaviours.  Conversely, we should not expect exceptional performance where adversarial and transactional participants tack a partnering charter onto their project.

When to Use Partnering

There are no hard rules that state when and when not partnering should be used. The following procurement features should inform us of when partnering is appropriate:

  1. Projects involve a relatively long-term commitment,
  2. Complex and high-risk projects,
  3. Delivery quality is of paramount importance,
  4. Significant scope exists for innovation, and
  5. Success will be underpinned by close collaboration between buyer and supplier (interdependency).

We also need to recognise that partnering is not just for acquisition activities but may also be applied to sustainment activities.

Crafting a Partnering Charter

The partnering charter must be developed collaboratively with all relevant stakeholders. Typically, workshops will be conducted well before contract signature to ensure the parties can reach agreement on the scope of the charter, protocols, and mutual objectives.  The charter must be consistent with the proposed commercial framework.  The United Kingdom, Joint Contracts Tribunal offers a useful template for drafting a partnering charter here.

The following are examples of partnering charters from various jurisdictions:

  1. Alberta Infrastructure and Transportation Projects (Page iv)
  2. Australian Department of Defence Frigate Enterprise Sustainment Charter (page 32) 
  3. Queensland Government Bruce Highway Upgrade Project (page 77)
  4. US Army Aviation and Missile Command CH-47 helicopter upgrade
  5. US Army Corp of Engineers Human Performance  Wing Construction Project (appendix F)
  6. United Kingdom Happisburgh to Winterton Sea Defences (page 6)

Commercial Arrangements

In some instances, we may wish to import some of the partnering principles into our head contracts. This requires careful consideration as some of the partnering ‘goals’ could create significant risks in terms of liability, indemnities, and insurance. Some of the lower risk partnering principles that could be incorporated into a head contract include:

  1. transparency provisions with obligations to report issues in a timely fashion,
  2. internal dispute resolution mechanisms that require internal resolution prior to seeking arbitration or litigation, and
  3. express good faith obligations.

We also need to consider the broader commercial framework including tender selection processes. Partnering will likely fail if we select suppliers purely on the basis of lowest price and we subsequently deal with suppliers in a clinical, arms-length fashion prior to contract signature.

Conclusions

Partnering offers substantial benefits provided the parties to the agreement have a suitable mindset and culture. Partnering alone will not realise exceptional performance but will assist in driving the parties towards the achievement of common goals, and reasonableness in projects.  A partnering charter is best crafted within a joint workshop environment, well before contract signature. We must also ensure our commercial framework is consistent with the partnering approach.


[1] US Army Corp of Engineers ‘Partnering’ https://www.iwr.usace.army.mil/Portals/70/docs/cpc/91-ADR-P-4_Partnering.pdf

[2] US Army Corp of Engineers Policy Memorandum 11, 7 August 1990.

[3] Adapted from Queensland Department of Transport and Main Roads ‘Transport Infrastructure Project Delivery System’ Volume 1 (2020)

[4] Briggs I., ‘Alliancing: Reshaping Infrastructure Delivery in Australia’ (2007).

[5] Andrew Stephenson, ‘Alliance Contracting, Partnering, Co-operative Contracting – Risk Avoidance or Risk Creation’ (paper presented to Clayton Utz Major Projects Seminar, Melbourne, October 2000).

[6] Alberta Infrastructure and Transport Partnering Guidelines (2007) at http://www.bv.transports.gouv.qc.ca/mono/0968447.pdf

[7] Weston D and Gibson G ‘Partnering-project performance in U.S. Army Corps of Engineers’Journal of Management in Engineering. 1993 Oct pp 410-425; Black, Akintoye, Fitgerald ‘An analysis of success factors and benefits of partnering in Construction’ International Journal of Project Management 18 (2000) 423-434. Contra R. Quick who claims that partnering has not been successful in Australia since ‘ the law gets in the way’ R. Quick ‘Queensland’s ECI Contract’ The International Construction Law Review 4 (2007).

Driving Collaboration with Joint Governance Arrangements

Well, everyone can master a grief but he that has it.” – W. Shakespeare ‘Much Ado about Nothing’ (1599)

Why Pursue Joint Governance?

To realise the full range of collaborative benefits, parties should adopt a joint approach to problem solving, risk management, communication, and decision making.  In other words, a joint governance approach is required as recommended by ISO 44001 Collaborative Business Relationships:

The partners shall establish and agree a formal foundation for joint working, including contractual frameworks or agreements, roles, responsibilities and ethical principles. A joint management team shall be established from the initiating organisation and its collaborative partner.[1]

Included in the governance structure is a need for:

  1. Joint Communications,
  2. Joint Knowledge Management,
  3. Joint Risk Management, and
  4. Joint Issues Resolution.[2]

Figure 1 below illustrates the key processes required for parties to work together collaboratively.

Figure 1 – ISO 44001 Working Together Processes[3]

Successful collaborative outcomes may not necessarily require all the above process to be joint. In some situations, it may not be possible to have a fully joint approach as each individual entity may face their own governance, legislative, and commercial constraints that prohibit sharing of all risks and information.  What the evidence shows is that where organisations are more tightly coupled and share information, superior value is more likely to be delivered.[4] 

Implementing Joint Governance

A joint governance approach is not something that is added to a relationship after contract signature, rather joint governance must be implemented throughout the procurement lifecycle.  The following areas should be contemplated to realise collaborative benefits:

Joint Risk Management.  Where parties work collaboratively to identify all relevant risks then a project is more likely to be successful. If each party manages their risks severally then there is greater scope for errors of omission and errors of commission in the risk management process.  Ideally, parties should engage collaboratively in the very early stages of a project (prior to contract signature) to run joint risk workshops and follow this with a joint liability risk assessment. This activity should then be followed by negotiated risk transfer where buyers and suppliers jointly agree who is best able to manage risks. The sharing of risks should also be contemplated here where appropriate.  Negotiated risk transfer approaches are often used in two stage managing contract approaches.[5] Once the contract is afoot, joint risk management should continue to; ensure there is a single source of truth with risks, effectively deal with new risks, and provide transparency in the relationship.

Joint Decision Making. A fully collaborative venture should pursue joint decision making to the maximum extent possible. Joint decision making encourages collaboration, reduces adversarial behaviours, and allows for greater agility and responsiveness in commercial dealings.  Joint decision making is a common feature of project alliances and other highly collaborative contract arrangements.[6] For many organisations, the prospect of joint decision making can seem daunting. Joint decision making does not mean that every commercial decision must be joint, rather those decisions relevant to project delivery should be joint. Joint decision making may be implemented at the operational level or even the programme board level.[7]  Where joint decision making is implemented, the prospect of deadlocks must be considered. Deadlocks may be resolved by the customer owning a ‘casting vote’ or through expert determination mechanisms.

Joint Communications. Collaborative ventures are far more likely to succeed where there is a common and timely communications framework. This is made clear in the Managing Successful Programmes framework; “the programme will need to control communications to ensure they are consistent, clear, timely and accurate”.[8] Coherence in communication mitigates the risks of disputes and issues arising and also supports a culture of ‘no surprises’.  Collaborative ventures should consider the use of shared systems to provide a common communications baseline.

Joint risk management, decision-making and communications should be integrated into the governance framework of the relationship making sure the contracts terms and conditions support such approaches. In addition to the head contract, the parties may wish to implement a joint program steering group that addresses the above.

Conclusions

Effective collaboration requires parties to work together to ‘fix the problem and not the blame’. This is far more likely to occur where parties engage in joint risk management, joint decision making and with joint communications. This does not mean that every decision must be joint, rather those decisions that would benefit from both buyer and supplier involvement should be joint.  Commercial frameworks need to be crafted to support joint outcomes. This is not just the contracts terms and conditions but also the statements of work, partnering charters, and other governance documentation.


[1] ISO 44001 Collaborative Business Relationships (2017) [8.6.2.1], [8.6.2.5]

[2] Ibid, pp 23-25.

[3] Ibid, Figure 7.

[4] See esp., UK Ministry of Defence ‘A Partnering handbook for Acquisition Teams’ (2008) pp 9-10; T. Lendrum ‘Building High Performance Business Relationships’ (2011); Arthur McInnis, ‘Relational Contracting under the New Engineering Contract: A Model, Framework and Analysis’ (paper presented to the Society of Construction Law, UK September 2003); State of Flux ‘Supplier Relationship Management Research Report 2012: Voice of the Supplier – A Step Closer to Mutual Benefit’ (2012).

[5] Queensland Government ‘Relational Procurement Options – Alliance and Early Contractor Involvement Contracts’ (2008)

[6] Australian Government ‘National Alliance Contracting Guidelines – Guide to Alliance Contracting’ (2015).

[7] Alexos, Managing Successful Programmes (2014) p 40.

[8] ibid, p 62.

Collaboration, Risk , and Remuneration

risk and cards

“It’s unwise to pay too much, but it’s worse to pay too little. When you pay too much, you lose a little money – that is all. When you pay too little, you sometimes lose everything, because the thing you bought was incapable of doing the thing it was bought to do.” – John Ruskin

 Introduction

In previous blogs we explored risk allocation and highlighted the fact that inappropriate risk allocation significantly erodes value and creates an immense barrier to collaboration.  We also observed that contractual risk allocation may often provide a false sense of security, especially in complex environments where uncertainty is rife, variations are prolific, and the customer rarely has clean hands. The solution is to select a commercial model that encourages a shared vision, shared risk and opportunities, and creates an environment where all parties win, or all parties lose.  How then can we create such a commercial framework?

Money at any cost?

In terms of profitability, a reasonable risk-adjusted rate of return is to be expected across the enterprise. This does not mean that each project, contract, or activity will yield the same rates of profit, rather the enterprise as a whole should be generating suitable profits in the interests of shareholders, current and future. This latter point is very important as short-term profit taking must be discouraged.

Commercial models must never jeopardise buyer or supplier cash flow or place business continuity at risk. We should never underestimate the importance of money as a motivational factor but, at the same time, we must also need to recognise that it is not just the contract value and remuneration strategy that will influence behaviours.

Remuneration and risk

The remuneration options available for a contract almost limitless.  We can select between the spectrum of cost-plus to firm fixed price arrangements, we can vary remuneration strategies throughout the contract life cycle, we can adopt different remuneration strategies for different packages of work, and we can frame payments in terms of sticks (liquidated damages) versus carrots (early completion bonuses).   The challenge in crafting and negotiating a commercial agreement is to strike a balance that meets the commercial needs of both parties whilst at the same time creating a framework that encourages problem solving, innovation, and the delivery of enterprise outcomes. In other words, how do we drive collaboration through the contract?

Best Practice Risk and Remuneration Strategies

In Andrew Jacopino’s blog on perverse incentives, he explores the phenomena where seemingly valid incentives can drive the wrong behaviours.  Our risk and remuneration strategy must be crafted to drive the right behaviours.  To achieve this, we need to strike a balance between monetary (fees and damages) and non-monetary (e.g. contract extension, increased contract scope, preferred supplier status) aspects.

Incentive based remuneration helps align the parties’ interests and drive collaboration. Incentive fee reimbursement includes; cost plus incentive fee, cost plus fixed fee, and cost-plus award fee options.[1] Remuneration of this type often requires the development of a Target Outturn Cost (TOC) against which the performance fee is determined.   A focus on achievement of the TOC alone though is insufficient. The commercial framework should also allow for price adjustment based on delivery quality, schedule, and any other key result areas. Adjustment of incentive fees can be a based on a combination of both carrots and sticks. For example, our carrots can include a bonus pool set aside for early delivery or for achieving superior quality outcomes (provided such outcomes are of value to the client). Conversely, we can rely on sticks such as abating incentive fees for late delivery or where quality fails to meet minimum requirements.  Such remuneration strategies must be crafted so that enterprise objectives are realised, all parties win or all parties lose, and the system is fair.

Challenges with Developing the Target Outturn Cost

The development of the TOC requires validation by the principal either by using inhouse capabilities or third-party estimators. Where there is an asymmetry of information, TOC integrity can introduce the risk that the TOC is set too high and result in erosion of value.  Typically, the TOC is set at the most likely value or P50 estimate of costs.  In some larger, complex projects the TOC may include an allowance for uncertainty (unallocated contingency).

Profit Sharing Arrangements

A more revolutionary approach for sharing risk and rewards is to adopt a profit-sharing arrangement.[2] This could be through an incorporated joint venture or a commercial model that focusses on rewards directly linked to the client’s commercial outcomes. An example of this latter approach is with Seimens’ energy efficiency initiative with Pilkington.[3] In this project, Seimens invested in energy efficient systems with upgrades to Pilkington’s equipment with the aim to reduce energy costs by £340,000 per annum.  Rather than adopt a service contract or other risk transfer model, Seimens was remunerated based on energy costs saved. The client incurred zero investment costs under this initiative.

We must ensure profit or revenue sharing arrangements must also be fair. If too much risk is passed to suppliers, then project success is unlikely.  The Boeing Dreamliner risk sharing approach where ‘no strategic suppliers will receive payment for the development cost until Boeing delivers its first 787 to its customers[4] actually incentivised suppliers to deliberately deliver late.  Situations such as this must be avoided.

Conclusions

Effective collaborative relationships must be underpinned by a fair and equitable risk allocation framework. Best practice risk allocation places an emphasis on risk sharing and incentive-based remuneration where buyers and suppliers are both liable for success or failure.  We must be alert to perverse incentives in our commercial framework and strive to craft a commercial model that drives the right behaviours and is fair.

[1] US Government Department of Defence ‘Guidance on Using Incentive and Other Contract Types’ (March 2016).

[2] Qin Z., and Yang J. “Analysis of a revenue-sharing contract in supply chain management” (2008) International Journal of Logistics 11(1) pp 17-29.

[3] “Siemens supports Pilkington’s investment in energy-efficiency at zero net cost Case Study: United Kingdom” at https://assets.new.siemens.com/siemens/assets/api/uuid:4a52b5f48d29507018d85b6d13b0a248e8a1d81a/version:1510824643/sfs-uk-pilkington-case-study.pdf

[4] Tang, C.& Zimmerman, J. & Nelson, J. ‘Managing New Product Development and Supply Chain Risks: The Boeing 787 Case’ Supply Chain Forum: an International Journal 10 (2009).

Disputes and Issues Resolution – Best Practice for Collaboration (Part 1)

“Bulls do not win bullfights; people do. People do not win people fights; lawyers do.” – Norm Augustine (Chairman and CEO of the Lockheed Martin Corporation)[1]

lawyers at twenty paces

Lawyers at Twenty Paces – L. Ruigrok

Introduction

In previous blogs we recognised that for effective collaborative, we require disputes and issues to be resolved at the lowest possible level, quickly, and fairly.  In an increasingly volatile economic environment, we should be investing in our business relationships to ‘engineer in’ resilience to the partnership to effectively deal with both high risks and uncertainty. To achieve this, we should not hobble ourselves with a business relationship that is likely to generate unnecessary disputes. In addition, we need a commercial framework that supports timely and effective resolution of disputes when they arise.

Resolving disputes and issues at lowest possible level, quickly, and fairly is an unremarkable observation but just how is this achieved? We certainly need to avoid litigation and the associated delays and extortionate costs involved in such actions. There are several strategies we can pursue to do so. These include preventative measures, to minimise the likelihood of disputes, and corrective measures to minimise the consequences of disputes. We previously explored how many disputes can be prevented through a fair risk allocation process and shared objectives. In other words, we can reduce the likelihood of disputes arising.  Despite our best attempts, disputes and issues may still arise and therefore we need to explore corrective measures to mitigate consequences.  Corrective measures include internal disputes resolution and external disputes resolution. The first part of this blog explores how we can effectively deal with internal dispute resolution.

Legal Frameworks

We need an understanding of how the law operates so that ‘the art of the possible’ is contemplated in our contract.  The ability to seek resolution of issues and disputes outside of the courts in common law countries is mostly unconstrained, provided that the commercial relationship does not attempt to ‘oust the jurisdiction of the courts’. This was not always the case. In the 19th century, there was a perverse incentive for the courts to encourage litigation and eschew arbitration as observed by Lord Campbell in Scott v Avery:

“…judges depended mainly or almost entirely upon fees and they had no fixed salary, there was great competition to get as much as possible of litigation into Westminster Hall, and a great scramble in Westminster Hall for the division of the spoil… [the courts] had great jealousy of arbitrations, whereby Westminster Hall was robbed of those cases which came neither into the Queen’s Bench, nor the Common Pleas, nor the Exchequer.”[2]

Fortunately, the decision in Scott v Avery recognises the validity of arbitration as a legitimate dispute resolution mechanism and many jurisdictions have subsequently enacted legislation that governs the arbitration process in contractual disputes.[3]

So long as a commercial agreement does not prohibit the courts for determining matters at some stage then there is great latitude in crafting effective disputes and issues resolution provisions in our contracts.   Only with the more radical ‘no disputes/no litigation’ clauses we see in some project alliance agreements can legal obstacles arise.

Prevention is Better Than Cure

In our previous blog on commercial models, we recognised that disputes and issues are far more likely to be minimised when we have:

  1. A shared vision;
  2. Early engagement;
  3. Fair and equitable risk allocation;
  4. A remuneration strategy where all parties win, or all parties lose;
  5. Openness and transparency; and
  6. Joint decision making.

These features will never eliminate disputes or issues but makes them far less likely.  We need to also recognise that when disputes or issues arise, this may not necessarily be a bad thing.  Where issues are raised in a timely and constructive manner, this could be a positive symptom of effective communication and a display of trust between the parties.  We should actively encourage prompt reporting of relevant issues and not allow them to fester.[4] How then do we incentivise such behaviours?

Encouraging Timely and Effective Dispute and Issues Resolution

Crafting a disputes and issues escalation process into a contract will encourage collaboration.  Parties should be committed to ‘fixing the problem and not fixing the blame’.[5] An example clause used to encourage such behaviour is as follows:

(a)       the parties agree that all disputes, differences of opinion and questions (Disputes) arising out of or in connection with this Agreement will be initially escalated and attempted to be resolved through the Joint Project Management Team.

(b)       The parties agree that their attempts to resolve Disputes will occur in a timely manner.  The parties will at all times, to the extent reasonably possible, seek to resolve the Dispute at the lowest appropriate level, act in a manner that will minimise any delay to the Project and that will minimise and mitigate the consequences of the parties or a party incurring any or any additional costs or liability.

(c)        If a Dispute cannot be resolved through the Joint Project Management Team within 14 days, the Dispute is to be referred to the respective parties’ Managing Directors for resolution.

Clauses such as the above drive parties to resolve issues at the lowest level and as quickly as practical.  Such mechanisms though will only be effective if all team members are aware of their obligations and leaders are committed to the above principles.

In addition to contract provisions, dispute and issues may also be addressed in a partnering charter.  The following is an extract from the Partnering Charter for the ANZAC Frigate Group Maintenance Contract.

No Blame Culture. A no blame culture exists when all personal are welcomed to raise all, and any issue with the knowledge of being treated fairly and without fear of retribution for raising the issue.

Problem Solving. In a no blame culture, problems are solved collaboratively to ensure we minimise consequences.

We must recognise that partnering charters may have no binding legal force; however, they are useful for focussing efforts of the parties in meeting mutual objectives.

More radical disputes and issues resolution strategies involve a commercial framework with an express ‘no disputes/no litigation clause’.  These provisions are used in extensively in project alliance agreements.[6]  No litigation clauses such as the above deviate from most contracts in that the parties rely on a gainshare/painshare remuneration framework to drive performance.  Whilst a noble attempt to foster collaboration, a no litigation framework is very risky from a legal perspective as such clauses do attempt to oust the jurisdiction of the courts.  Many other risks with a no litigation/no liability framework also exist including

  1. Ability to gain insurance (since no liability exists).
  2. Lack of enforceability making the consideration illusory, and
  3. Potential creation of fiduciary duties. [7]

A no disputes/no litigation commercial framework certainly maximises the likelihood of positive collaborative outcomes but also introduces new, substantial risks.

Conclusions

Whilst prevention is better than cure, we must  anticipate disputes and issues arising in our business relationships.  Our commercial framework must be crafted to deal with such issues at the lowest possible level, quickly, and fairly.  The contract terms themselves can achieve such outcomes as can a suitable partnering charter.  In the next part of our discussion on disputes and issues resolution, we will explore external mechanisms such as expert determination, mediation, and other novel techniques to resolve disputes whilst still preserving positive business relationships.

[1] N. Augustine “Augustine’s Laws” (1986)

[2] Scott v Avery (1856) 10 ER 1121

[3] See e.g: Arbitration Act 1996 (UK); Commercial Arbitration Act, RSC 1985; Arbitration Act 1996 (NZ); Commercial Arbitration Act 2010 (NSW).

[4] CASG Better Practice Guide Collaborative Contracting (2017) [31].

[5] Derek Walker,Beverley Lloyd-Walker, “Anthony Mills Innovation through Alliancing in a No-Blame Culture” (2013)

[6] Australian Government “National Alliance Contracting Guidelines Guide to Alliance Contracting” (2015) p16-17. https://www.infrastructure.gov.au/infrastructure/ngpd/files/National_Guide_to_Alliance_Contracting.pdf

[7] Trevor Thomas ‘Alliance Contracts: Utility and Enforceability’ (2007) 23 Building and Construction Law 329, 335-7